UK prime minister Gordon Brown says he will plug tax loopholes that help private equity executivesnews
29 September 2007

Britain''s Prime Minister Gordon Brown sent ripples through the country''s risk capital industry on Wednesday 26 September, when he warned that private equity (PE) tax loopholes would be closed.

The PM was referring to the fact that in Britain, some private equity bosses pay capital gains tax at the rate of 10 per cent on the profits they make from investments they have held for at least two years, rather than income tax at the maximum rate of 40 per cent. The tax breaks were originally introduced to encourage entrepreneurs.

A flaming controversy erupted in June after CVG Capital chairman Nicholas Ferguson admitted before a cross-party committee of British MPs that, as a result, cash-rich equity executives paid lower rates of income tax than even the cleaners who are the lowest-paid employees of PE firms!

From 2008, Brown abolished the 10 per cent rate, formerly the lowest rate of income tax for low-wage earners, so all UK taxpayers will be charged at either 20 per cent or 40 per cent from next April. On the other hand, many PE executives pay as little as 5 per cent tax after they have written-off loss-making investments against tax. Unions accuse the firms of profiteering at the expense of workers'' jobs, pensions and benefits.

Nowadays, the prime minister''s every word is carefully examined for hints he may call an early general election this fall. So, the PM may have been playing to the gallery of his Labour Party faithful when he told a Labour Party conference audience: "Whenever there is a loophole that shouldn''t exist, we take action," in response to a question by a trade union delegate about the low rates of tax paid by private equity executives and directors of private equity-owned companies.

"Since 1997, we have closed a massive number [of loopholes]," Brown continued. "Sometimes it is very difficult, because you have lawyers and accountants who are always trying to find these loopholes. But on this issue of private equity, I can assure you we will do so," he emphatically concluded.

But any such move would be a reversal of Labour''s previous position. As recently as June, Chancellor of the Exchequer Alistair Darling ruled out any "knee-jerk" tax increases after trade unions and Labour MPs strongly criticised the tax provisions for private equity. He warned then that this could potentially damage London''s finance industry, which is responsible for a major chunk of Britain''s economic growth.

Treasury officials have, however, confirmed that two reviews are underway: one into the rules on shareholder loans offered by private equity firms as part of their equity investments in portfolio companies, and the other into general issues of remuneration and taxation of private equity officials and portfolio company managers. Announcements are expected only after the pre-budget report is released in October.

But industry players believe the battle is far from lost. They say Brown''s words do not portend an immediate change in the tax rules. British Venture Capital and Private Equity Association (BVCA) chairman Wol Kolade, managing partner at Isis Equity Partners, told an international private equity conference later on Wednesday that the industry generated £26 billion ($53 billion) in taxes for the UK government and benefited millions of retired people through the high rates of return it produced for pension fund investors.

"To say that the private equity industry does not bring benefits to the wider economy is simply not a serious argument," Kolade said. The industry position is that the co-investment amounts required to be able to carry interest are very high, and represent a substantial level of risk, which is why it should be treated as capital, rather than income.

The BVCA announced that it would be very concerned if anything happened that would affect the British competitive position at such a time of uncertainty in the world''s financial markets. On its part, the Unite union warned the government not to backtrack on its pledge ahead of the pre-budget report next month, when a review is due to be published into the tax loopholes enjoyed by private equity companies.

Private equity firms have consistently warned that any changes to their tax treatment would damage the industry and lead to a flood of businesses moving to lower tax jurisdictions. A representative for private equity firm 3i said some large firms could quit Britain if they faced a harsher tax regime; the number of deals would decline, hitting one of Britain''s flagship industries, which has driven growth in the economy in recent years.

The private equity industry worldwide is fighting criticism of its low tax regimes and is seeking to restore its image as a responsible investor that preserves jobs and strengthens local companies. On Wednesday, the European Venture Capital Association (EVCA) sent the draft of a new proposed Code of Ethics to its stakeholders — including unions, academics, investors, regulators and politicians — for amendment, comment and suggestions, before it can be finalised.

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UK prime minister Gordon Brown says he will plug tax loopholes that help private equity executives